This
year’s budget hit mutual fund investors very badly. Not only it levied Long
Term Capital Gain Tax @10% on Equity Funds but also introduced 10% dividend
distribution tax on dividend declared by Equity Funds. Post demonetization and
stiff fall in interest rates large chunk of flow came to mutual fund. It’s
really unfortunate that large chunk of fund came in balanced funds which
invests minimum 65% in equity under monthly dividend option with so called assured
1% return every month. Product was largely missold to the senior citizens who
were looking for the regular income every month. The dividend now is falling
and new investors are realizing that something is wrong but still most of them
are in confused mind. The dividend option takes away 10% in equity funds and
around 29% in debt funds.
Normally
dividend is declared when there is good appreciation in the NAV due to better
performance by the scheme compared to bench mark. But, in practice it is largely
misused to garner the new business which is what happening in recent time. Most
of the people do not understand this sales pitch and are lured to invest in the
fund without understanding the risk involved in the scheme. What exactly
happens if dividend is declared can be understood by an example. Suppose “X” an
equity fund scheme has NAV of Rs. 20 in growth option as well in dividend
option. The scheme was launched at Face Value of Rs. 10 few years back. Suppose
the Fund house today decides to declare Rs. 1.20 per unit i.e. 12% as dividend
in the dividend option. In above case after the ex-dividend NAV of Growth
option in “X” fund will remain the same at Rs. 20 but NAV under the dividend option will come down to Rs. 18.80
as Rs. 1.20 is paid back to investor by way of dividend. By looking at attractive
12% dividend income you opt to invest Rs. 10,000 which investors have done in
recent times. Most of the lay investors think that they will get same kind of
dividend every year which is not true. The returns in equity are volatile and
also not guaranteed. The corpus can also go negative and fund manager can’t
declare dividend if there is no surplus generated. You have to remember while
investing in mutual fund that past performance is not indicator of future
returns and returns can vary depending on market.
According
to me dividend option does not make any sense in both equity and debt. Let us
understand the implications for both separately. First if you want regular
income periodically than equity is not the correct asset class to invest. Opting
for dividend option in debt funds is worst as there is a dividend distribution
tax of around 29% compared to 10% in equity funds. Most of the investors are
not aware of this because DDT is directly deducted by the AMCs before paying
dividend to them. Also distributors do not tell or are not aware of this facts.
On
other hand equity investment comes under high risk high return category. You
should invest in equity after understanding the risk involved in it. You must invest in equity only if your time
horizon is long term say 5 years or more so that you get better inflation
adjusted returns. So if you want to take the advantage of India’s growth you
should stay invested in equity for longer period of time. Dividend option
reduces your investment by dividend declared amount in equity so it will not
give you advantage of power of compounding in longer run. So in equity also
dividend option is not advisable.
Dividend
Distribution Tax reduces overall return and it is right time to say Good Bye to
dividend option. If you want a regular income opt for Systematic Withdrawal
Plan in debt funds and avoid equity funds for regular income. Tax planning is
very important part of financial planning which most investors ignore. You
should know final outcome of the investment post tax and also study the hidden
charges while taking financial decision.
To
conclude making a new investment in mutual fund on the basis of dividend
declared is not at all a good idea. You should take informed decision before
investing in mutual fund schemes. You should consult a professional if you want
regular flow of income every month and also know tax implications. Investing
for short tern gain without understanding the long term impact may hit you
badly. SEBI must also intervene and should abolish dividend reinvestment option
and also stop monthly dividend option in equity funds to protect the interest
of investors.
This article first appeared at indianotes.com on 20th June 2018
https://www.indianotes.com/en/articles/say-good-bye-to-dividend-option/
